Bill Gross is getting feisty. The bond guru took shots at the economy, 100-year historical stock patterns, personally called out legendary Wharton professor Jeremy Siegel by likening his analysis of the stock market to a Ponzi scheme, and declared stocks dead.
The big declaration from Bill was that the 6.6% annual gain on an inflation-adjusted basis that the stock market has provided in the past 100 years is a “historical freak, a mutation likely never to be seen again.”
Harsh words. But he’s not just down on stocks, expecting them to return closer to 4% per year in the future; he also thinks bonds are likely to be stuck in a 2% annual return pattern going forward. If you’re evenly diversified between stocks and bonds, he says to expect inflation-adjusted returns of zero.
Bah, humbug. And by the way, you’re out of your mind, Bill.
Without a doubt, Bill is a great investor. His economic analysis is often spot-on, and his firm has won big on several big macro calls in the past. And one thing I like about Bill is that he speaks his mind. But in this case — as in several other times in recent past — he couldn’t be more wrong.
In fact, this call is a curious case of déjà vu from his prediction back in October 2009. Bill said then:
“Investors must recognize that if assets appreciate with nominal GDP, a 4%-5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets — while still continuously supported by Fed and Treasury policymakers — is likely at its pinnacle.”
Of course, the Dow went on to rally another 3,000 points during the next three years. But that’s not all that makes me think Bill may be losing his macro touch.
He was wrong on his call last year regarding the Fed and Treasury bonds. He expected bond yields would climb once the Fed stopped buying bonds under the QE2 program in June — in fact, we saw just the opposite happen as bond yields marched steadily lower.
And he was wrong back in 2002 when he called for the Dow to fall to 5,000. Instead, the market soared, peaking at 14,000 five years later.
So what is the right forecast of future stock returns? I don’t have a crystal ball, but the market is much more attuned to earnings than it is to U.S. GDP growth. And for good reason, since Bill’s argument that the stock market can’t — or at least shouldn’t — return more than U.S. GDP growth is much too simplistic. Nearly half of the S&P 500’s revenues today are generated globally. Just 10 years ago, global revenues were closer to 30%.
Right now, the S&P is trading at about 14 times earnings, a discount to its historical average, with an earnings yield of just over 7% — this is a company’s earnings per share divided by its share price, and it’s right now close to the highest on record when compared to yields offered by 10-year Treasury bonds.
Click to Enlarge The fact is that right now we are at an inflection point. The S&P 500 yields more than Treasury bonds for the first time in 55 years, and the market has tremendous appreciation potential.
With an average dividend yield of approximately 2.2%, the S&P 500 is an oasis for many yield-oriented investors, and reversion to the mean means stocks are cheap and bonds are expensive. As investors chase yield, we’re going to see liquidity improve and money pour into the market.
Some of the best buys right now are defensive, high-dividend stocks that have been attracting tremendous buying pressure.
Perhaps Bill should stick to bonds and leave the 1979 “Death of Equities” headlines to BusinessWeek.